[Federal Register: December 26, 1996 (Volume 61, Number 249)]
[Notices]
[Page 67998-68013]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
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COMMODITY FUTURES TRADING COMMISSION
Chicago Board of Trade Futures Contracts in Corn and Soybeans;
Notice That Delivery Point Specifications Must Be Amended
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of, and request for public comment on, Notification to
chicago board of trade to amend delivery specifications.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'') has
notified the Board of Trade of the City of Chicago (``CBT''), under
Section 5a(a)(10) of the Commodity Exchange Act (``Act''), 7 U.S.C.
7a(a)(10), that the delivery terms of the CBT corn and soybean futures
contracts no longer accomplish the objectives of that section of the
Act; and that the CBT has seventy-five days from the date of this
notice to submit proposed amendments to those contracts which will
accomplish the objectives of that section.
The Commission has determined that publication of the notification
to the CBT for public comment is in the public interest, will assist
the Commission in considering the views of interested persons, and is
consistent with the purposes of the Commodity Exchange Act.
DATES: Comments must be received by February 24, 1997.
ADDRESSES: Comments should be mailed to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington,
D.C. 20581, attention: Office of the Secretariat; transmitted by
facsimile at (202) 418-5521; or transmitted electronically at
[secretary@cftc.gov]. Reference should be made to ``Corn and Soybean
Delivery Points.''
FOR FURTHER INFORMATION CONTACT: Blake Imel, Acting Director, or Paul
M. Architzel, Chief Counsel, Division of Economic Analysis, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,
N.W., Washington, D.C. 20581, (202) 418-5260, or electronically, Mr.
Architzel at [PArchitzel@cftc.gov].
SUPPLEMENTARY INFORMATION: Section 5a(a)(10) of the Act provides that
as a condition of contract market designation, boards of trade are
required to:
permit the delivery of any commodity, on contracts of sale thereof
for future delivery, of such grade or grades, at such point or
points and at such quality and locational price differentials as
will tend to prevent or diminish price manipulation, market
congestion, or the abnormal movement of such commodity in interstate
commerce. If the Commission after investigation finds that the rules
and regulations adopted by a contract market permitting delivery of
any commodity on contracts of sale thereof for future delivery, do
not accomplish the objectives of this subsection, then the
Commission shall notify the contract market of its finding and
afford the contract market an opportunity to make appropriate
changes in such rules and regulations.
The Commission, by letter dated December 19, 1996, notified the CBT
under Section 5a(a)(10) of the Act, that its futures contracts for corn
and soybeans no longer were in compliance with the requirements of that
section of the Act. The text of that notification is set-forth below.
December 19, 1996.
Patrick Arbor
Chairman, Chicago Board of Trade, 141 W. Jackson Blvd., Chicago,
Illinois 60604
Re: Delivery Point Specifications of the Corn and Soybean Futures
Contracts.
Dear Chairman Arbor: The Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') hereby notifies the Board of Trade of
the City of Chicago (``CBT or Exchange'') under Section 5a(a)(10) of
the Commodity Exchange Act (``Act''), 7 U.S.C. 7a(a)(10), that the
delivery terms of the CBT corn and soybean futures contracts no
longer accomplish the statutory objectives of ``permit[ting] the
delivery of any commodity * * * at such point or points and at such
quality and locational price differentials as will tend to prevent
or diminish price manipulation, market congestion, or the abnormal
movement of such commodity in interstate commerce.'' <SUP>1
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\1\ The full text of Section 5a(a)(10) of the Commodity Exchange
Act is appended to this letter.
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The Commission, as detailed below, bases this finding on the
following: (1) the continuing diminution of the role of terminal
markets in the cash market for grain; (2) the increasing shift of the
locus of the main channels of commodity flows away from the delivery
points on the contracts, particularly the par-delivery point of
Chicago; (3) the continuing decline in cash market activity generally
at the contracts' delivery points, particularly Chicago; and (4) the
serious, precipitous drop in regular warehouse storage capacity at the
Chicago delivery point
[[Page 67999]]
over the past fourteen months. These conclusions are supported by a
number of CFTC staff inquiries into these issues and by four separate,
comprehensive studies of these issues completed in 1991 (one of which
was sponsored by the CBT). Each of these inquiries and studies
identified the above trends and indicated that deliverable supplies on
the subject contracts were not available in normal cash market channels
in amounts sufficient to tend to prevent or to diminish price
manipulation, market congestion, or the abnormal movement of such
commodity in interstate commerce.
Although the CBT has attempted previously to respond to these
problems by amending the contracts, those steps, such as the addition
of St. Louis as a delivery point, have proven to be ineffective. With
the recent precipitous drop in warehouse capacity in Chicago, the
problem has reached a critical juncture. Recognizing this, the CBT
convened a Task Force to consider changes to the grain contracts. More
than a year after the Task Force began its deliberations, the Exchange
membership rejected the modifications to the terms of the corn and
soybean contracts recommended by the CBT's Board of Directors.
And, as provided under section 5a(a)(10) of the Act, the Commission
hereby notifies the CBT that the Exchange is afforded the opportunity
to submit for Commission approval proposed amendments to the delivery
terms of the corn and soybean futures contracts that will accomplish
the statutory objectives by March 4, 1997, a period of seventy-five
days from the date of this letter. In determining whether its proposal
is adequate to accomplish the objectives of section 5a(a)(10) of the
Act, the CBT should be guided by a number of illustrative alternatives
provided below. Failure to respond in a manner which in the
Commission's judgment is ``necessary to accomplish the objectives'' of
this section of the Act will result in further proceedings under
section 5a(a)(10).
In light of the Commission's determination that the CBT's futures
contracts in corn and soybeans no longer comply with the requirements
of section 5a(a)(10) of the Act, the CBT should refrain from listing
additional months for trading in those contracts during the pendency of
these proceedings.
By limiting this notification under Section 5a(a)(10) of the Act to
the CBT's futures contracts for corn and soybeans, the Commission is
not thereby making any determination regarding any other CBT futures
contract. The Commission notes, however, that the delivery
specifications for the CBT wheat futures contract are also subject to
many of the same trends which have affected adversely the corn and
soybean contracts. In light of the importance of these issues, the
Commission determined to limit this Section 5a(a)(10) notification to
the corn and soybean contracts, which have been fully considered by the
CBT in the first instance. The Commission believes that such a full
consideration by the CBT of the delivery specifications of its wheat
contract is also warranted and should be undertaken immediately. The
Commission is of the view that this reconsideration should be completed
within 120 days.
In notifying the CBT of the Commission's finding that the terms of
the corn and soybean futures contracts do not accomplish the objectives
of Section 5a(a)(10) of the Act, the Commission is not questioning the
continued utility of the contracts for hedging or price basing under
ordinary conditions or their role as the world's premiere futures
contracts for corn and soybeans. Rather, the Commission's action, as
explained in greater detail below, is predicated upon its finding that
bringing the delivery terms of the contracts into closer alignment with
an otherwise broad and active cash market is necessary to meet the
requirements of Section 5a(a)(10), tending to prevent or to diminish
price manipulation, market congestion, or the abnormal movement of such
commodities in interstate commerce.
I. Background.
The CBT's corn and soybean futures contracts are major United
States (U.S.) futures markets and principal vehicles for hedging and
pricing by U.S. firms with commercial interests in these two important
agricultural commodities. They rank among the most actively traded
commodity futures contracts in the world and are used extensively by
foreign commercial interests. In this regard, for the 1995/96 crop
year, the average daily open interest was nearly two billion bushels
for CBT corn futures and approached one billion bushels for CBT soybean
futures. The total trading volume over the same period was
approximately 95 billion bushels for corn futures and 70 billion
bushels for soybean futures.
These activity levels for corn represent a greater than eight-fold
increase in the levels of volume and open interest experienced in these
markets in the early 1970s. For soybeans, these current levels are more
than four times the levels experienced in the early 1970s. This
increased overall level of trading activity can be attributed to an
approximate 80 percent increase in the combined U.S. annual production
of corn and soybeans over the last 25 years; a steadily decreasing
level of federal crop price support activities, which has led to
increased commercial uncertainty and need for hedging; and an increased
internationalization of cash markets for feed grains and soybeans,
which has also led to increased foreign participation in these futures
markets for purposes of hedging and price-basing.
The preponderant use of these markets is commercial in nature. For
example, in mid-November of this year, reportable commercial traders
held 60 and 70 percent of the reportable long and short sides,
respectively, of the soybean futures market and 85 and 64 percent of
the reportable long and short sides, respectively, of the corn
market.<SUP>2 Presumably, commercial traders also held a substantial
proportion of the non-reportable positions.
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\2\ Reportable traders are individuals or firms that hold
futures positions of 500,000 bushels or more in soybeans or 750,000
bushels or more in corn in any one contract month through any U.S.
or foreign broker.
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The predominant economic function of the CBT corn and soybean
futures markets is risk-transfer and price-basing, rather than
merchandising or title transfer for the underlying commodity.
Consistent with this, the preponderance of positions established in
these markets are liquidated through the purchase or sale of offsetting
futures contracts, rather than through making or taking delivery of the
commodity. Nonetheless, the orderly convergence of futures prices and
cash market merchandising values is essential to these contracts' risk-
transfer and price-basing functions, and this convergence is dependent
on the unimpeded opportunity of market participants to conduct
arbitrage between the cash and futures markets. As a result, it is
essential that the delivery specifications of these contracts
effectively link futures trading to a substantial segment of the
underlying cash markets.
The manner in which cash and futures prices are linked through the
delivery mechanism is straightforward. If, at contract expiration,
short position holders believe that expiring futures prices are higher
than the current value of the commodity, they can satisfy their
contractual obligations by acquisition and delivery of the physical
commodity, rather than through the purchase of offsetting futures
contracts. Likewise, if long position holders believe that
[[Page 68000]]
expiring futures prices are lower than the current merchandising value
of the commodity, they can require delivery in lieu of selling
offsetting contracts in the futures market. To the extent that this
arbitrage process is not impeded, convergence of cash and futures
prices at contract expiration is assured.
The terms of delivery are critical in determining the degree of
arbitrage between cash and futures markets and the strength of the
linkage between cash and futures prices. When contract delivery terms
do not correspond to a substantial segment of the cash market, the
strength of the arbitrage linkage is diminished. In particular, when
the futures market requires delivery at a location or of grades for
which the commodity is not sufficiently available, short position
holders may not be able to acquire the commodity or gain access to the
delivery facilities in the event they believe that cash and futures
prices are misaligned. Long position holders, seeking to profit from
their positions, have no incentive to liquidate their positions through
offset, and futures prices may take a course that is independent of the
cash market. The resulting market congestion, or distortion of prices,
is disruptive to proper functioning of the futures market, because
prices no longer reflect cash market fundamentals. Thus, the nature of
the delivery terms is critical to use of the CBT's corn and soybean
futures contracts throughout the U.S. and abroad in the hedging and
pricing of corn and soybean transactions and directly determines the
degree to which the prices of the futures markets may be manipulated or
otherwise become independent of fundamental conditions in those cash
markets.
As discussed in detail below, the CBT's corn and soybean contracts
currently specify delivery through the use of warehouse receipts for
stocks held in specified facilities at Chicago, Toledo, and St. Louis.
It is the location of these delivery points, as well as the nature of
the delivery instrument, that is the subject of the Commission's
analysis regarding the CBT's compliance with the provisions of Section
5a(a)(10) of the Act.
II. General Cash Market Trends
Chicago and Toledo, the primary delivery points of the CBT's corn
and soybean futures contracts, are now situated at the periphery of
current major cash market channels for these commodities. Their
declining importance as cash market centers is the result of long-term
trends in the storage, transportation, and processing of grains. As
discussed below, these trends include: (1) increasing shipment of corn
and soybeans from production areas directly to domestic users or export
locations, bypassing intermediate locations such as terminal markets;
(2) increasing processor use of corn and soybeans in production areas,
to produce food, feed, and other products, thereby reducing the
relative quantity of corn and soybeans shipped to locations outside of
production areas including terminal markets; (3) substantially
declining export activity from the Great Lakes relative to the growth
of exports from Gulf of Mexico and Pacific Northwest ports; and (4)
increasing decentralization in grain storage capacity, with marked
increases in both on-farm and commercial storage capacity in production
areas.
1. Changes in Transportation Patterns
The increasing shipment of corn and soybeans directly from
production areas to domestic users or export locations, bypassing the
traditional terminal markets, is related, in large part, to the
deregulation of railroad freight rates. Prior to rail freight-rate
deregulation in 1980, a practice called ``transit'' or
[[Page 68001]]
``proportional billing'' permitted grain to be shipped from production
areas to an intermediate point for storage, such as a traditional
terminal market, and then to the final destination at a single, fixed
rate. After 1980, negotiated point-to-point rates replaced transit
billing, favoring direct shipments of corn and soybeans to domestic
users or export locations, to the detriment of traditional terminal
markets located at major railroad centers such as Chicago.
2. Processing Trends
Substantial increases in corn and soybean processing at new and
existing locations within the major production areas has further
reduced the role of traditional terminal markets. According to U. S.
Department of Agriculture (USDA) data, the quantity of corn processed
into corn sweeteners, ethanol, and other products quadrupled between
1970 and 1995 (from about 400 million bushels to over 1.6 billion
bushels) and the quantity of soybeans crushed in the U.S. approximately
doubled over the same time period (from about 760 million bushels to
about 1.34 billion bushels). Most of these new or expanded facilities
are located in production areas, in which the processors obtain their
supplies of corn and soybeans directly from nearby grain warehouses or
producers. Moreover, even processing facilities located at terminal
markets now purchase the majority of their supply directly from lower-
cost production-area locations rather than from terminal market
elevators. The inability to participate in this growth sector of the
cash market has further eroded the relative importance of traditional
terminal-market elevators.
3. Export Marketing Channel Changes
Over the past 25 years, corn and soybean exports have grown
dramatically. However, the trends favor the all-year export facilities
of the lower Mississippi River. In addition, the growth in exports to
Asia has favored export facilities at Pacific Northwest ports. The
growth in exports from these two areas has relatively disadvantaged the
third major export route--the Great Lakes. More fundamentally, corn and
soybean exports from the Great Lakes have declined absolutely, as well.
This decline is, in part, attributable to the fall in exports to
Northern European countries where Great Lakes ports sometimes have a
cost advantage relative to other U.S. ports. In addition, exports from
the Great Lakes are limited by the relatively high cost of shipping
corn and soybeans by vessel from Great Lakes ports. This is partially
due to the fact that the St. Lawrence Seaway, through which all vessels
from Great Lakes ports must pass, can accommodate only relatively small
vessels, which tend to charge higher freight rates for grain shipments
than those assessed by larger vessels. In view of this consideration,
corn and soybeans frequently are transferred from such smaller ships to
larger vessels at Canadian ports.
These changes have significantly eroded the role, and general
business activity, of the Great Lakes ports and the traditional
terminal markets located there. For example, USDA data indicate that
average annual exports of corn from Chicago and Toledo combined fell by
33 percent between 1968-70 and 1993-95. Average annual soybean exports
from Toledo and Chicago over this same period fell by 53 percent. In
addition, the percentage of total U.S. exports of corn and soybeans
accounted for by Chicago and Toledo combined declined from an average
of about 17 percent in the 1968-70 period to an average of about four
percent in the 1993-95 period.
As the following charts indicate, the decline in the export role of
Chicago and Toledo has been associated with, and is in contrast to, the
increasing importance of corn and soybean exports through ports on the
Gulf of Mexico and on the Pacific Coast.<SUP>3
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\3\ Ports located on the lower Mississippi River accounted for
about 93 percent of average annual soybean and corn exports from
Gulf of Mexico ports over the period 1993-95. Virtually all Pacific
Coast exports of corn and soybeans move through Pacific Northwest
ports located on the Columbia River and Puget Sound.
BILLING CODE 6351-01-P
[[Page 68002]]
[GRAPHIC] [TIFF OMITTED] TN26DE96.000
[[Page 68003]]
[GRAPHIC] [TIFF OMITTED] TN26DE96.001
BILLING CODE 6351-01-C
[[Page 68004]]
4. Geographic Changes in Storage Capacity Location
Finally, the role of some terminal markets as grain storage centers
has declined as increasing storage capacity has been constructed in
production areas, both off-farm and on-farm. Increases in off-farm
storage capacity in production areas is due, in part, to the
deregulation of rail freight rates, increased processing activity in
production areas, and the need for additional storage capacity due to
the significant growth in corn and soybean production in recent
decades. In addition, on-farm storage capacity has increased
significantly over the past 25 years to allow producers to maintain
harvesting efficiency and access to lower cost storage. As a result,
the role of terminal markets as storage centers has greatly diminished.
III. Cash Market Conditions at CBT Delivery Points.
As indicated above, general cash market trends disfavor traditional
terminal markets such as Chicago. Moreover, cash market activity in
Chicago and Toledo, the primary delivery locations for the CBT's corn
and soybean futures contracts, has declined substantially, both on an
absolute and relative basis, in recent decades. USDA production data
and CBT data on grain receipts by elevators and processors at the
primary delivery locations indicate that, despite U.S. corn production
nearly doubling from 1970 to 1995, total corn receipts at Chicago and
Toledo combined increased only by about 26 percent from 1970 to 1995,
representing a mere 2.5 percent of total U.S. corn production in 1995.
These data also indicate that, while U.S. soybean production also
nearly doubled over this period, total soybean receipts in these
locations actually fell by about 64 percent during the 1970-95 period,
representing less than 2 percent of total 1995 U.S. soybean production.
These trends illustrate the peripheral nature of the delivery points of
the CBT's corn and soybean futures contracts to the cash market for
these commodities.
The decline in the importance of the primary CBT delivery locations
relative to the cash market is further illustrated by the trends in
storage capacity at these locations in relation to changes in storage
capacity in states which contain primary production areas for corn and
soybeans. In particular, USDA data indicate that, from January 1, 1970,
to December 1, 1995, total off-farm storage capacity in Illinois more
than doubled, whereas CBT data for the same period indicate that the
registered storage capacity of regular elevators at Chicago remained
essentially constant until 1995, when it fell by about 58 percent.
Similarly, during the period January 1, 1978, through December 1, 1995,
total off-farm storage capacity in Illinois, Indiana and Ohio combined
increased by about 42 percent, whereas total regular storage capacity
in Chicago and Toledo combined declined by about 15 percent. This
decline includes the 25 percent decrease in total regular storage
capacity during 1995.
The decline in the cash market importance of the primary CBT
delivery points has not been uniform. Rather, the declining cash-market
importance of Chicago, the par delivery point, has recently been
particularly acute.
1. Cash Market Trends at Chicago
Chicago's decreasing cash market role has been reflected over the
years in a gradual loss in regular elevator storage capacity and in the
number of firms operating such elevators. As discussed in more detail
below, this loss has recently become precipitous. According to CBT
data, in 1970, five firms operated seven regular elevators with a total
registered storage capacity of about 52.4 million bushels. Currently,
there are only three firms operating three regular elevators, with a
total registered storage capacity of 22.8 million bushels. Further, one
of the three remaining regular elevators, representing about 8.1
million bushels of storage capacity, recently ceased accepting grain
and soybeans and appears to be closing down its operations, leaving
total registered storage capacity at 14.7 million bushels.
Currently, soybean cash market activity in the Chicago area is
limited to the merchandising by regular elevators of soybeans received
from production locations, generally at harvest time. In this regard,
total annual soybean receipts by regular CBT elevators declined by
about 86 percent from 1970 to 1995, to about 8 million bushels. The
merchandising role played by CBT regular elevators essentially is
limited to shipping soybeans into export channels, either by barge to
lower Mississippi River export points or via vessels through the Great
Lakes and the St. Lawrence Seaway.
The existing corn cash market in the Chicago area primarily
consists of purchases of corn by two local processing facilities and
the merchandising by regular elevators of corn received from production
locations. Annual receipts of corn in Chicago in 1995 totaled 112
million bushels, remaining relatively unchanged since 1970. CBT data
indicate that a very small share of these receipts is received by
regular elevators, with these elevators accounting for only about 14
percent of total corn receipts in 1995. Further, corn processing
facilities in Chicago purchase essentially all of their annual corn
requirements directly from production areas rather than from regular
elevators. As with soybeans, regular elevators merchandise the limited
quantities of corn they receive primarily into export channels.
USDA data indicate that average corn exports via the Great Lakes,
during the period 1993-95, declined in absolute terms by over 60
percent relative to the average levels observed in 1968-70 and, as a
percentage of total U.S. exports, from about 11.3 to 1.2 percent.<SUP>4
These data also indicate that average soybean exports via the Great
Lakes declined by approximately 70 percent between these same two time
periods and, as a percentage of total U.S. exports, from about 7.3 to
about 1.1 percent.
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\4\ These data actually overstate the level of corn and soybean
exports from Chicago, because the USDA's export data for Chicago
also include exports from Milwaukee.
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2. Cash Market at Toledo
Corn and soybean cash market activity in Toledo has been less
affected by these trends than the par delivery point of Chicago. Since
Toledo was added as a delivery point for corn and soybeans in the mid-
to late 1970s, the number of regular elevators in Toledo has remained
relatively stable, although overall registered storage capacity has
increased from about 36 million bushels in 1978 to about 57 million
bushels today. Currently, there are seven regular elevators at the
Toledo delivery point. The cash market for corn and soybeans at Toledo
consists exclusively of the merchandising activities of the regular
elevators; there are no processing facilities for these commodities at
this location.
From 1970 to 1995, annual receipts of corn at Toledo doubled,
increasing to an average of about 65 million bushels during 1994-95.
Despite the overall doubling of receipts, however, average corn exports
via the Great Lakes, during the period 1993-95, exceeded by only about
20 percent the average levels observed in 1968-70. In contrast, soybean
receipts at Toledo declined in absolute amount by about 30 percent over
this same period to an average of about 30 million bushels during 1994-
95. Average soybean exports from Toledo declined by an even greater
amount--approximately 47 percent between these same two time periods.
Thus, while these data indicate that
[[Page 68005]]
Toledo, unlike Chicago, has retained a larger measure of cash market
activity, it is of a decidedly mixed nature.
3. Cash Market Conditions at St. Louis
Cash market activity at the contracts' St. Louis delivery point is
of a substantially different nature than at the contracts' two primary
delivery points. This location primarily serves as a barge loading area
for corn and soybeans for shipment to the lower Mississippi River
export market. The four regular elevators currently at St. Louis have a
registered storage capacity of 12.2 million bushels. CBT data indicate
that these elevators handle relatively large quantities of corn and
soybeans. Specifically, receipts of corn averaged 52 million bushels
during the period 1994-95, while receipts of soybeans averaged 23
million bushels over this same period. Similar quantities of corn and
soybeans were shipped (almost exclusively by barge) during these two
years. However, regular elevators at this location do not store
significant quantities of corn or soybeans for extended periods of time
due to the need to keep storage space unencumbered in order efficiently
to conduct the unloading/loading process. Accordingly, because delivery
on the CBT's corn and soybean contracts calls for the issuance of
warehouse receipts that require regular elevators to store the
commodity until the receipt is redeemed, there have been only a token
number of futures deliveries at St. Louis.
IV. History of Revisions to the CBT Corn and Soybean Futures Delivery
Point Specifications--1973 to 1993
The trends discussed above are long-term in nature. There has been
an equally long history of modest attempts, made only in response to
the urging of the federal regulator, to address the effect of these
trends on the continued viability of the delivery terms of these
futures contracts, while retaining the primacy of Chicago. Until the
1970's, Chicago was the sole delivery point on the CBT's corn and
soybean futures contracts. At that time, a number of problem
liquidations and price manipulation investigations in these futures
markets focused attention on the inadequacy of Chicago as a delivery
point and the need for additional delivery points. In particular, in
the summer of 1973, both futures markets experienced problem
liquidations, due, in part, to a general tightness in supplies
associated with large Soviet grain purchases. Later that year,
Congressional hearings were held in response to these problems.
Ultimately, as part of far-reaching amendments to the Act, Section
5a(a)(10) was added, providing for new federal authority to address
directly the delivery point provisions of futures contracts.
1. Proposals to Add Toledo and St. Louis
In 1974, the CBT submitted proposals to the USDA's Commodity
Exchange Authority, the Commission's predecessor agency, to add Toledo
and St. Louis as delivery points on the corn and soybean contracts at a
discount of 5 cents per bushel to Chicago.<SUP>5 The CBT never placed
these amendments into effect, because the proposed discounts were
thought to be too great relative to cash market pricing relationships
between Chicago and the proposed delivery points. In 1975, these same
amendments were resubmitted to the newly formed CFTC for its approval.
The Commission approved the proposal for corn (effective with the
December 1976 contract month); and the CBT withdrew the soybean
proposal. In 1978, the CBT resubmitted the proposal to add Toledo (but
not St. Louis) as a delivery point for the soybean contract at a
discount of 8 cents per bushel. The Commission approved those
amendments, effective with the November 1979 contract month.
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\5\ Toledo was established by the CBT as a delivery point for
its wheat futures contract in the early 1970s.
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2. Proposal to Add St. Louis as a Soybean Futures Delivery Point
In July 1989, a commercial long trader held large long positions
that exceeded the amount of soybeans that short traders were able to
deliver at the contract's then existing delivery points and indicated
that it would stand for delivery on its positions. This prompted the
CBT to declare a market emergency, taking action to ensure an orderly
liquidation of that futures contract month. In response to the
outpouring of concerns over the adequacy of the contract's delivery
provisions expressed by market participants after this incident, the
CBT in 1990 proposed a number of changes to its soybean and grain
futures contracts. These included adding St. Louis as a delivery point
for soybeans at a discount of 4 cents per bushel to Chicago. Based upon
evidence that the proposed discount for St. Louis delivery was too
great relative to cash market pricing relationships, the Commission
returned this submission for further justification under Commission
Rule 1.41(b). The Commission also reiterated its view that the CBT
should consider more substantive changes to its soybean and grain
futures contracts in order to ensure adequate deliverable supplies.
In response to the heightened concerns over the adequacy of the CBT
grain and soybean delivery points renewed by the July 1989 market
emergency, the National Grain and Feed Association, the CBT, the
General Accounting Office, and the Commission all conducted or
sponsored studies on the delivery terms of the soybean and grain
futures contracts. These separate studies were all completed in 1991.
They generally found that long-term trends in the structure of the
grain industry had affected adversely the viability of the cash markets
at Chicago and Toledo. Their specific conclusions are summarized below.
a. MidAmerica Institute
The CBT commissioned the MidAmerica Institute to conduct a study of
its corn and soybean futures contracts. The study concluded that, based
on an analysis of cash and futures price data for the 1984-89 period,
the delivery process for these contracts effectively resulted in the
convergence of futures prices and cash prices at the contracts' Chicago
and Toledo delivery points. The study noted, however, that the Chicago-
Great Lakes-East Coast cash market for grains and soybeans had declined
markedly in importance relative to the Mississippi-Gulf of Mexico area.
The study concluded that this decline had reduced the benefits of
retaining Chicago as the primary delivery point and of relying upon
Toledo as the alternative delivery point. In this respect, the study
concluded that Chicago had become a relatively low price point because
it is located near the origin, rather than at the destination, of grain
and soybean flows for most of the year. The study indicated that this
feature enhances the potential for manipulation, since deliverable
supplies may only be increased to address a manipulation attempt by
drawing these commodities from higher value locations. The study noted
that such an action to increase deliverable supplies is costly and that
a manipulator can profitably exploit this cost to inflate futures
prices artificially under conditions that recur periodically in grain
markets. The study also noted that the decline in Chicago's tributary
area means that more hedgers must bear additional basis risk when
Chicago is the primary delivery point.
This increased susceptibility to manipulation and basis risk, the
study concluded, could be ameliorated by improving the alignment of the
contracts' delivery mechanisms with
[[Page 68006]]
prevailing cash market conditions and pricing relationships. In
particular, the addition of an effective Mississippi River delivery
point, such as St. Louis, and the establishment of price differentials
for all delivery locations at levels reflecting typical cash price
relationships, was recommended. The addition of a delivery point at an
active cash market location such as St. Louis, the Institute noted,
would enhance the futures contracts' hedging performance by improving
the extent to which their prices reflect prices in primary cash market
channels. In this regard, however, the MidAmerica Institute cautioned
that, because of their limited storage capacity and throughput nature,
the addition of St. Louis warehouses would only modestly enhance
deterrence of manipulative activity.\6\
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\6\ Providing for emergency barge or rail delivery, or for some
mechanism of ensuring access of throughput elevators in the vicinity
of that city to the delivery process, would, according to the
MidAmerica Institute, address these shortcomings in St. Louis as a
potential additional delivery point.
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b. Food Research Institute
The Food Research Institute of Stanford University was commissioned
by the National Grain and Feed Association to study these issues as
well. This study concluded that deliverable stocks at the contracts'
delivery points were, in the years preceding the study's completion in
1991, too low relative to the size of positions normally held by the
largest traders. It concluded that, in this respect, positions held by
the largest traders were of such a size relative to deliverable stocks
that neither delivery nor the threat of delivery was a credible
alternative. Moreover, this limited level of deliverable stocks was not
due to any warehouse capacity constraints existing at that time, but
rather to the general inexorable decline of cash market activity at
grain terminal markets--Chicago, in particular.
The Food Research Institute recommended that the CBT address this
fundamental problem by rethinking its specifications requiring delivery
of grain and soybeans in-store via warehouse receipts. Suggested
alternatives included barge delivery, incorporating aspects of a call
on production, or delivery at Mississippi River export facilities, with
the receiver given the option as to when the product is loaded upon one
month's notice.\7\
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\7\ The Food Research Institute study suggested that the CBT
consider adopting the delivery procedures used on the New York
Mercantile Exchange's crude and heating oil futures contracts if the
CBT selects a Gulf of Mexico delivery point system.
---------------------------------------------------------------------------
c. The CFTC
The Commission staff's study of the contracts' delivery terms
reviewed and analyzed the general cash market trends and the specific
cash market conditions at Chicago and Toledo during the period 1960
through 1990. The study found that Chicago and, to a lesser extent,
Toledo had declined substantially as storage locations for corn and
soybeans to be exported via the Great Lakes and shipped to other U.S.
destinations for domestic consumption purposes. In addition, the study
analyzed several potential alternative delivery-point specifications
for the corn and soybean futures contracts, which would locate the
contracts' delivery points within the commodities' primary cash market
channels. These included delivering corn and soybeans in-store at
Central Illinois warehouses via warehouse receipts; making delivery at
Illinois River barge-loading, or Mississippi River vessel-loading
export facilities via shipping certificates; and cash settlement. The
study concluded that these alternatives, by aligning the contracts'
terms more closely with the underlying cash markets for corn and
soybeans, would thereby reduce the potential for market problems and
concomitant regulatory interventions.
d. General Accounting Office (GAO)
At the request of the Chairman of the Agriculture Committee of the
U.S. House of Representatives, the GAO completed a review of the CBT
grain and soybean futures delivery-point issues in 1991. The GAO
conducted interviews of interested parties, including CBT and
Commission officials, and reviewed the above-noted studies prepared by
the MidAmerica Institute and the Stanford University Food Research
Institute.
In its study, the GAO noted that CBT officials believed that
changing delivery points might interfere with the economic purposes of
futures trading and that surveillance and disciplinary action programs
rather than changing delivery points might be better suited to
preventing potential market manipulation. The GAO noted that, in
contrast, the Commission was reluctant not to alter futures contract
terms that in its judgement resulted in an increased threat of
manipulation and required an excessive level of regulatory intervention
to prevent frequent market congestion, price distortions or
manipulation. The GAO also noted that the MidAmerica and Food Research
Institute studies supported the need for the CBT and the Commission to
assess alternatives for improving how delivery points for grain and
soybean futures contracts meet the economic purposes and anti-
manipulation goals of the Act.
e. Symposium on CBT Grain and Soybean Delivery Point Issues
In conjunction with the completion of these studies, in September
1991, the Commission sponsored a symposium to discuss these issues.
Attendees at that symposium represented a broad cross section of
interested parties, including major grain companies, academic
institutions, the CBT, and the Commission. Members of the grain
industry generally agreed that the performance of the futures contracts
under their current delivery specifications was not satisfactory in all
respects, but disagreed on the degree of the problem and the nature of
the possible solutions. Although acknowledging that Chicago was a
declining cash market, a CBT representative nevertheless maintained
that Chicago was still a viable delivery point based upon the variety
of transportation alternatives available to long traders taking
delivery at that location. The CBT representative further indicated
that the CBT was continuing to study the situation and develop
appropriate revisions to the contracts' delivery specifications.
f. Final CBT Proposals Responding to July 1989 Soybean Incident
In 1992, the CBT re-submitted its proposal to add St. Louis as a
delivery point for soybeans, at a premium of 8 cents per bushel rather
than at a discount of 4 cents per bushel as previously proposed in
1990. The CBT also proposed to revise the price differential for St.
Louis corn futures deliveries to a premium of 7 cents per bushel from
the then existing 4 cents per bushel discount and to reduce the
discount for the delivery of corn in Toledo to 3 from 4 cents per
bushel. Although approving these proposals in April 1992 for
implementation beginning with the December 1993 corn contract month and
the November 1993 soybean contract month, the Commission, in its
approval letter, stated that it:
understands that the addition of St. Louis as a delivery point for
soybeans and wheat and revisions to locational differentials for
corn were intended by the Exchange to provide additional deliverable
supplies for these contracts. Nevertheless, the Commission is
concerned that these changes may not be sufficiently responsive to
the long run changes in the cash market, and therefore may not
significantly alleviate concerns about the contracts' specifications
in either the immediate future or the long run.
[[Page 68007]]
In particular, in view of the long term trends in the cash
market, the Commission is concerned about the continued reliance on
warehouse receipts in terminal markets as the sole source of
deliverable supplies for each of these contracts. Further, the
Commission notes that the limited warehouse space at St. Louis may
be devoted primarily to ``through-put'' merchandising activities
and, as a result, operators of these facilities may be reluctant to
make significant space and/or receipts available for purposes of
futures delivery.
The Commission concluded by again putting the CBT on notice that:
[i]n consideration of this, the Commission believes that the CBT
should continue its efforts to develop comprehensive contract
revisions that will enhance deliverable supply and reduce the need
for formal and informal market intervention by the Exchange or the
Commission. It is the Commission's belief that such revisions may
require linking contract terms more directly to commodity flows or
to decentralized storage. In the Commission's view, continued active
consideration of this matter is particularly advisable in view of
the possibility of further declines in the viability of the Chicago
delivery area and the time necessary to develop and fully implement
more substantive contract changes.
V. Recent Events--1995 to the Present
As predicted by the Commission in 1992, the CBT's response to the
continuing deterioration of the cash market at its delivery points
proved to be a solution of limited effect and short duration. In the
fall of 1995, three of the existing six Chicago delivery warehouses
ceased operations. As a result, Chicago delivery capacity was
immediately reduced by more than half--from 53.9 to 22.8 million
bushels. Significant as this drop in capacity is, it must be kept in
mind that actual supplies available in those warehouses have been a
fraction of the total capacity. Nevertheless, the precipitous drop in
warehouse capacity served to reawaken concerns over the viability of
the contracts' delivery points.<SUP>8
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\8\ Moreover, as also anticipated by the Commission in 1992,
there have been few, if any, warehouse receipts registered for
delivery on the soybean (or wheat) futures contracts at St. Louis,
since it became a soybean (and wheat) delivery point in 1993. In
addition, despite the substantial increase in the locational price
differential applicable to St. Louis corn futures deliveries under
the 1992 amendments, there continues to be very little futures
delivery activity in corn at that location.
---------------------------------------------------------------------------
Commission Chairman Mary Schapiro, in an October 11, 1995, letter
to the CBT, expressed once again the Commission's concerns regarding
the adequacy of the contracts' delivery provisions, stressing that the
Commission's concerns were heightened by this further deterioration.
Chairman Schapiro requested that the Exchange keep the Commission staff
informed on a frequent basis of the progress of a Special Task Force
established by the CBT to study the situation. Chairman Schapiro's
letter further noted the Commission's recommendation that the Exchange
not limit its consideration to short-term responses to the closure of
the above-noted Chicago regular elevators. The letter noted,
specifically, that the Exchange should consider, in the context of
long-run cash market trends, comprehensive contract revisions that
would enhance deliverable supply and provide a viable price-basing
service for the international grain industry.
1. CBT Task Force.
As noted above, the halving of deliverable storage capacity at
Chicago prompted the CBT to form a Special Task Force on September 25,
1995, to determine what changes, if any, were needed to be made to the
contracts' delivery terms to ensure adequate deliverable supplies. The
Special Task Force held numerous meetings from the date of its
establishment through early June 1996. It invited a significant number
of individuals, representing a broad cross section of the industry and
other interests, to express their views. It considered in depth the
merits of a number of suggested alternatives. The Special Task Force's
Chairman also briefed the Commission on its progress.
On June 4, 1996, the CBT Special Task Force issued its final
recommendations for changing the delivery provisions of the grain
futures contracts. The Special Task Force recommended: (1) adding
delivery points in East Central Illinois, Northern Illinois River
locations, and Milwaukee, Wisconsin, for the corn and soybean
contracts, with warehouse receipts continuing to serve as the delivery
instrument; (2) reducing the locational price differentials for
delivery of corn, soybeans, and wheat at Toledo, Ohio; (3) deleting St.
Louis as a delivery point for the corn, soybean, and wheat futures
contracts; (4) reducing the daily barge load-out requirement for
Chicago elevators from 3 to 2 barges, but permitting the receivers of
corn or soybeans to request up to 4 barges per day, which the Chicago
warehouseman could provide either entirely from the Chicago elevator or
through a combination of loadings at the Chicago elevator and a
separate loading point along the Northern Illinois River; and (5)
establishing higher minimum financial requirements for regular
warehousemen.
2. March 1996 Wheat Expiration Problem
In the midst of the Special Task Force's deliberations, the March
1996 wheat futures contract experienced a problematic
liquidation.<SUP>9 On the last trading day of this future, a major
commercial trader maintained a significant long position against export
sales contracts and a major commercial trader who did not own wheat in
deliverable position maintained a significant short position until the
final few minutes of trading. The commercial short trader and several
other short position holders elected to offset their positions rather
than make delivery. During the final minutes of trading, this buying
interest was met by a lack of selling interest--the large commercial
long trader had determined to stand for delivery and had not entered
any orders on the close. As a result, wheat futures prices were bid
sharply higher, from about $5.00 to over $7.00 per bushel during and
after the close of trading. Although the Commission staff report
<SUP>10 on this incident was not addressed to the causal links, if any,
between the delivery specifications for the contract and the problem
liquidation, the recent problem in the expiration of the March wheat
futures contract may foreshadow similar problems for the corn and
soybean futures contracts.
---------------------------------------------------------------------------
\9\ As noted above, although this notification under section
5a(a)(10) of the Act applies only to the CBT corn and soybean
futures contracts, many of the same trends affecting the corn and
soybean futures contracts have affected the wheat futures contract,
as well. The Commission is requesting the CBT to conduct an in-depth
reconsideration of the delivery specifications for its wheat
contract within the next 120 days, similar to that which it
undertook for its corn and soybeans futures contracts.
\10\ See, Report on Chicago Board of Trade March 1996 Wheat
Future Expiration on March 20, 1996, (November 26, 1996).
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3. CBT Action on Proposals to Revise the Contracts
On September 18, 1996, the CBT's Board of Directors considered the
Special Task Force's recommendations and approved for membership
balloting all of the Special Task Force's recommended changes except
the proposal to add East Central Illinois as a delivery area. On
October 17, 1996, the Exchange membership voted to reject the
recommended changes by a margin approximately of 2 to 1.
4. More Recent Developments
In the last week of October 1996, Commission staff were notified
that one of the three remaining Chicago elevators, operated by
Countrymark, has stopped accepting soybeans and grain for the
indefinite future. Accordingly, at
[[Page 68008]]
present, there are only two functioning regular Chicago elevators. They
have a combined rated storage capacity of 14.7 million bushels.<SUP>11
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\11\ Trade sources indicate that, if the latest elevator to stop
accepting grain and soybeans closes, the effective regular storage
capacity in Chicago which is available to hold grain and soybeans
will be reduced to an even lower level, to about 12.0 to 12.5
million bushels. These lower effective capacity estimates reflect
the fact that a certain proportion of storage within an elevator
must be kept empty to allow blending of the stored grain and
soybeans and for the efficient movement of these commodities into
and out of the facility.
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VI. Requirements of Section 5a(a)(10) of the Act
The Commodity Exchange Act was extensively amended in 1974. Those
amendments substantially expanded the Act's scope, created a regulatory
system for the trading of all commodity futures contracts, and created
the Commission as an independent regulatory agency to administer and to
enforce the Act's provisions. Many of these amendments were designed to
address apparent weaknesses in the prior statutory scheme. In this
regard, the Commission's predecessor agency, charged with administering
the Act, testified before the House Committee on Agriculture, that:
For many years, the Department has been urging the exchanges to
provide an adequate number of delivery points in the production
areas and along the routes by which the various commodities move
from the producer to the consumer. The need for such points is
readily apparent. On July 20, 1973, the last trading day for July
corn on the Chicago Board of Trade, the futures price rose $1.20 per
bushel. * * * Transportation problems made it difficult to move corn
into the Chicago area and warehouses in that area were either filled
or reluctant to accept corn coming in for delivery on the futures
contract. The result was that many who would have made delivery had
there been provision for delivery at other points where supplies are
ordinarily available * * * were * * * forced to buy futures
contracts at an escalating price largely caused, not by an overall
change in the supply or demand for corn, but an artificial shortage.
* * *
[T]he establishment of * * * additional delivery points * * *
ought to be made by the exchanges in the first instance. Our concern
here is simply making sure that if they do not do the job properly,
adequate authority is present for the regulatory agency to take
action should such be desirable.
H.R. Rep. No. 975, 93rd Cong. 2d Sess. 77 (1974).
In recognition of the crucial role played by adequate deliverable
supplies in promoting orderly markets, Congress enacted Section
5a(a)(10) of the Act, which specifies, in part, that each contract
market is required to:
permit the delivery of any commodity, on contracts for sale
thereof for future delivery of such grade or grades, at such point
or points and at such quality and locational price differentials as
will tend to prevent or diminish price manipulation, market
congestion, or the abnormal movement of such commodity in interstate
commerce.
7 U.S.C. Sec. 7a(a)(10).
Moreover, Congress granted the Commission authority under Section
5a(a)(10) of the Act to determine whether exchange rules regarding
delivery terms fail to accomplish these objectives and to take
appropriate remedial action.
As an aid to the exchanges in meeting the statutory requirements
for designation, including the provisions of Section 5a(a)(10), the
newly formed Commission published Guideline No. 1 (now codified at 17
CFR Part 5, Appendix A). As explained in Guideline No. 1, to
demonstrate continuing compliance with the Act, exchanges must provide
evidence that each individual contract term conforms with the
underlying cash market and provides for a deliverable supply that will
not be conducive to price manipulation or distortion and which can be
expected to be available to the short trader, and saleable by the long
trader at its cash market value in normal cash marketing
channels.<SUP>12
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\12\ Specifically, with respect to delivery points, Guideline
No. 1 provides that exchanges must consider: (1) the nature of the
cash market at the delivery point; (2) the composition of the market
at that point; (3) the normal commercial practice for establishing
cash market values and the availability of published cash prices
reflecting the value of the deliverable commodity; (4) the level of
deliverable supplies normally available, including the seasonal
distribution of such supplies; and (5) any locational price
differentials that would be applicable to the delivery points,
including the economic basis for discounts or premiums, or lack
thereof, applying to delivery points. In addition, Guideline No. 1
specifies that contract markets must provide information which
describes the delivery facilities, including: (1) the type of
delivery facility at each delivery point; (2) the number and total
capacity of facilities meeting contract requirements; (3) the
proportions of such capacity expected to be available for traders
who may wish to make delivery, and seasonal changes in such
proportions; and (4) the extent to which ownership and control of
such facilities is dispersed or concentrated.
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VII. Compliance of the CBT's Corn and Soybean Delivery Point
Specifications with Section 5a(a)(10) of the Act
The Commission believes that the CBT's corn and soybean futures
contracts currently do not meet the requirements of Section 5a(a)(10)
of the Act that delivery terms be specified which ``tend to diminish
price manipulation, market congestion, or the abnormal movement of such
commodity in interstate commerce.'' As noted, the current level of
total regular capacity in Chicago available for the storage of
deliverable corn, soybeans, wheat, and oats has been reduced by about
60 percent since the fall of 1995, as three of the six regular Chicago
warehouse operators closed operations. Moreover, effective regular
storage capacity could decline to even lower levels (about 12 million
bushels of effectively available storage capacity) in the very near
future in view of the potential that another existing regular elevator
may cease operations. With the withdrawal of three--and now, apparently
four--elevators at the contracts' Chicago delivery point, the available
deliverable supplies potentially have been reduced to levels which
increase the futures contracts' susceptibility to price manipulation or
distortion.
The recent closure of these elevators in Chicago greatly
exacerbates a deliverable supply situation that is already severely
limited due to the low levels of cash market activity in Chicago. These
closures confirm that Chicago is at the periphery of normal cash market
channels for corn and soybeans. The reduced number of regular
warehouses, the frequently low levels of stocks available, and the lack
of commodity flows to Chicago resulting from normal cash market
activities increase the likelihood that futures prices may become
distorted and that abnormal interstate movements of corn or soybeans
may be required to meet futures delivery requirements.
Moreover, this situation is not confined to Chicago, the primary
delivery point on the contracts. The inadequacy of the contracts'
overall delivery point specifications is suggested by the very low
deliverable supply conditions frequently observed at season-end for the
corn and soybean futures contracts during recent years. As shown in
Chart 3, season-end deliverable stocks of corn at all CBT delivery
points combined have often fallen to very low levels from 1980 to the
present, independent of the recent precipitous decline in regular
storage capacity in Chicago. In particular, deliverable stocks of corn
fell to as low as 2 million bushels (400 contracts) on September 1,
1990. As shown in Chart 4, since 1980, deliverable stocks of soybeans
at all delivery points combined also have declined to levels as low as
1.2 million bushels (240 contracts) in 1985 and 1.05 million bushels
(210 contracts) in 1996.<SUP>13 Further, effective deliverable stocks
of corn (stocks at Toledo and Chicago minus stocks at St. Louis) have
declined to even lower levels on other occasions.\14\ For instance, on
September 1, 1996, effective corn stocks fell to about 1.1 million
bushels (about 220 contracts).
---------------------------------------------------------------------------
\13\ The low levels of corn and soybean stocks at the contracts'
delivery points observed in September 1996 were associated with low
stock levels throughout the U.S. Nevertheless, it is clear that low
stocks at the contracts' delivery points are
[[Page 68009]]
also a problem in years where U.S. stock levels are not at uniformly
low levels.
\14\ As discussed above, there have been very few deliveries at
St. Louis since this location became a delivery point in the 1970s.
The lack of deliveries at this point reflects the fact that
elevators in St. Louis, unlike the regular elevators in Chicago and
Toledo, operate as barge-loading facilities rather than storage
facilities. Corn and soybeans received at St. Louis elevators are
stored only temporarily until they can be loaded into barges.
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BILLING CODE 6351-01-P
[[Page 68010]]
[GRAPHIC] [TIFF OMITTED] TN26DE96.002
[[Page 68011]]
[GRAPHIC] [TIFF OMITTED] TN26DE96.003
BILLING CODE 6351-01-C
[[Page 68012]]
Charts 3 and 4 also indicate the comparative levels of open
interest for the expiring September contract month and the spot month
speculative position limits for the corn and soybean futures contracts.
These figures indicate, for instance, that total stock levels
frequently have fallen to levels near or below the maximum number of
contracts a single speculative trader may hold during the delivery
periods of expiring contract months (600 contracts). Moreover,
commercial firms may have been granted exemptions from these limits for
purposes of bona fide hedging. These comparisons show that the
potential requirements for futures delivery frequently exceed, by a
substantial degree, the level of deliverable stocks available for
futures contracts. They thereby indicate the increased potential for
market problems as well as the increased potential for regulatory
intervention required to ensure that positions are liquidated in an
orderly fashion.
Moreover, the recent loss of substantial regular warehouse capacity
likely will cause further deterioration in the chronically low
deliverable stock situation. The primary factor drawing deliverable
supplies to Chicago has been the existence of warehouse capacity for
futures contract deliveries at that location, rather than traditional
cash market demand. Numerous trade sources and cash market experts have
verified that the cash market flow of corn and soybeans to Chicago
elevators for purposes other than futures delivery is weak or non-
existent. Accordingly, the Commission believes that the recent decline
in the number of grain merchandisers in Chicago will necessarily result
in a further decline of stocks from the low levels depicted in the
charts.
In such situations, where stocks are available for delivery only at
chronically low-levels due to the location of a contract's delivery
points at the periphery of cash market channels, futures prices can
more become distorted relative to cash market prices. This results from
the need to attract the necessary quantities of corn or soybeans, which
are otherwise not normally available, to the contracts' delivery points
to fulfill delivery requirements. Thus, when the delivery points for a
futures contract are not located within active cash market channels for
the underlying commodity, the likelihood increases that abnormal
interstate movements of the commodity will be required to meet futures
delivery requirements. In contrast, when a contract's delivery points
are located within active cash market channels for a commodity,
deliverable supplies readily can be made available for delivery from
stocks at, or flows of the commodity through, the contract's delivery
points at a price that is representative of prevailing cash market
prices for the commodity.
These circumstances were clearly envisioned by the MidAmerica
Institute study discussed above, which concluded that because Chicago
had become a low price point, deliverable supplies required to respond
to an attempted manipulation could only be drawn from higher value
locations, thereby enhancing the potential for, and possible
profitability of, market manipulations.\15\
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\15\ The inclusion of Toledo does not cure this fundamental flaw
because it, too, is on the periphery of the cash market.
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The situation is critical in that, except for cash-settled
contracts, the threat of delivery is the mechanism through which the
market forces futures and cash prices to converge. To the extent that
delivery is not a viable alternative because of inadequate deliverable
supplies, trading will increasingly require regulatory intervention to
remain orderly, particularly during contract month expirations.
Accordingly, the Commission has determined to notify the CBT under
the provisions of Section 5a(a)(10) of the Act, that for the reasons
discussed above, and in light of the CBT's failure to date to take
appropriate corrective action, the Commission finds that the CBT rules
specifying the terms of its corn and soybean futures contracts do not
accomplish the Section 5a(a)(10) objectives of ``tend[ing] to prevent
or diminish price manipulation, market congestion, or the abnormal
movement of such commodity in interstate commerce.''
Further, the Commission hereby notifies the CBT, under the
provisions of Section 5a(a)(10) of the Act, that the CBT has until
March 4, 1997 to adopt and submit for Commission approval ``appropriate
changes'' to CBT rules.
VIII. Alternative Contract Specifications.
To avoid further proceedings under Section 5a(a)(10), the CBT must
make changes to the contracts which, in the opinion of the Commission,
are necessary to accomplish the objectives of this subsection of the
Act. Although the Commission has not reached a conclusion as to the
exact nature of the changes which are ``necessary to accomplish the
objectives'' of providing delivery terms ``as will tend to prevent or
diminish price manipulation,'' it is providing guidance to the CBT on a
range of possibilities which could constitute ``appropriate changes''
by providing for the necessary, viable linkage with the cash market. By
providing these alternatives, the Commission is not limiting the CBT's
ability to respond to this Section 5a(a)(10) notification, nor is it
specifying exact design criteria. Rather, these are examples of various
means by which the Commission believes the objectives of the section
could be met. In any event, the particular contract specifications
proposed by the CBT in response to this notification, in order to meet
the statutory requirement, should provide for a linkage with the cash
market through specific terms which are in conformity with a
substantial segment of that underlying market.
1. Modified CBT Special Task Force Proposal
The contract amendments recommended by the CBT Special Task Force,
with certain modifications, could potentially provide for the necessary
increase in deliverable supplies. Under the Special Task Force
proposal, futures delivery would continue to be made at all locations
by the transfer of a warehouse receipt for grain in store. Chicago and
Toledo would continue as delivery points, with Chicago remaining the
par delivery location, St. Louis being deleted, and existing discounts
for Toledo delivery being reduced to 2 from 3 cents per bushel for corn
and to 4 from 8 cents per bushel for soybeans.
The Special Task Force also proposed that delivery be permitted at
regular warehouses in Milwaukee, in East Central Illinois (ECI), and on
the Northern Illinois River (NIR).<SUP>16 Vessel deliveries of corn and
soybeans in Milwaukee would be at par, with rail and barge deliveries
subject to a discount of 8 cents per bushel. Corn and soybeans in store
at regular ECI warehouses would be deliverable at discounts of 4 cents
and 8 cents per bushel, respectively.<SUP>17 Futures delivery at NIR
warehouses would be at par for corn and at a discount of 4 cents per
bushel for soybeans.
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\16\ The ECI delivery area would encompass the counties of
Champaign, Coles, Douglas, Ford, and Iroquois. The NIR delivery area
would consist of that part of the Illinois River that lies between
Creve Coeur and Chicago.
\17\ The recommended changes also would permit delivery
receivers to require ECI regular warehouses to load the delivery
corn and soybeans into barges at NIR barge-loading facilities at a
premium of 4 cents per bushel. This provision implies that corn
would be deliverable in barges on the NIR at par, while soybeans
would be deliverable on the NIR at a discount of 4 cents per bushel.
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[[Page 68013]]
However, as to this proposal, the following changes would be
necessary to provide for an economically effective linkage of the
---------------------------------------------------------------------------
futures contracts with the cash market:
1. In view of the infrequent participation of St. Louis as a
delivery point, as well as the similarly limited storage capacity
and through-put nature of the barge-loading warehouses on the NIR,
the Special Task Force proposal to permit delivery in NIR barge-
loading warehouses must be modified to allow delivery at off-water
warehouses located within a specified distance of this portion of
the Illinois River, in order to make warehouses located on the NIR
an effective source of deliverable supplies.<SUP>18 The specified
area should encompass corn and soybean storage facilities that
typically store these commodities on a seasonal basis and from which
substantial deliverable supplies would be available.
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\18\ As recommended by the Special Task Force for deliveries at
ECI warehouses, the receiver of corn and soybeans in an off-water
warehouse could be given the option of taking delivery of corn and
soybeans in barges from regular warehouses on the NIR or by rail
from the off-water facility.
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2. The recommended locational price differentials for delivery
in store at Toledo, the ECI, and warehouses located on or near the
NIR should be modified so that they reflect commonly observed cash
price relationships with the contracts' other delivery locations.
Specifically, for deliveries at NIR barge-loading facilities, the
price differential levels selected should reflect the fact that corn
and soybeans become more highly valued the further south the
delivery location is on the NIR.
2. Illinois River Shipping Certificate Delivery Alternative
An alternative specification that could also result in the
necessary increase to deliverable supplies would replace the existing
warehouse-receipt-delivery instrument with a shipping certificate and
provide for delivery at Illinois River barge loading facilities, in
addition to the contracts' existing Chicago, Toledo, and St. Louis
delivery points.<SUP>19 The Illinois River delivery area could be
specified to include all or a substantial part of that River. The
contracts' par pricing location could be shifted to a delivery
location/area that has an active cash market, with locational price
discounts for other delivery points/areas set at levels that fall
within the range of commonly observed cash price differences between
the specified delivery locations.
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\19\ The terms of the shipping certificate could be specified in
several different ways. For example, the shipping certificate could
require that the issuer ship corn or soybeans in rail cars or trucks
to a location nominated by the buyer within the specified delivery
areas, with the buyer having the option of requiring that the corn
or soybeans be loaded into barges at a specified premium.
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3. Lower Mississippi River Export Alternative
This alternative would eliminate the contracts' existing delivery
locations and delivery instrument in favor of an export-oriented
contract with a shipping certificate as the delivery instrument. The
shipping certificate would call for delivery at export locations on the
lower Mississippi River.<SUP>20
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\20\ As in alternative 2, the shipping certificate's terms may
be specified in different ways. In this case, for example, the
shipping certificate could require the issuer to deliver corn or
soybeans in barges or rail cars to an export location on the lower
Mississippi River specified by the buyer, with provision for
delivery corn and soybeans to be loaded into vessels at a specified
premium.
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4. Cash Settlement Alternative
This alternative would replace the contracts' existing delivery
provisions with cash settlement provisions. The cash price index could
be based on the USDA-quoted prices for corn and soybeans in the primary
production or export market areas on the last day of trading or any
other method of calculating a cash-settlement price consistent with
Guideline No. 1.
Section 5a(a)(10) of the Act authorizes the Commission to change or
supplement the terms and conditions of futures contracts. The
Commission would prefer, however, not to take such an action. Rather,
the Commission looks forward to receiving for its approval proposed
modifications from the CBT to the delivery specifications for the CBT's
corn and soybean futures contracts which satisfactorily address the
issues discussed in this letter. In the event that the Commission fails
to receive such proposed amendments by March 4, 1997, the Commission is
prepared to take appropriate action under Section 5a(a)(10) of the Act
to address the situation.
By the Commission,
Jean A. Webb,
Secretary of the Commission.
The Commission has determined that publication of the notification
to the CBT for public comment will assist the Commission in its
consideration of these issues, including in particular, the eventual
response of the CBT. Accordingly, the Commission is requesting written
data, views or arguments from interested members of the public.
Commenters are specifically requested to address the following issues:
1. To what extent do the current CBT delivery specifications for
corn and soybeans reflect the structure of the cash market for the
underlying commodity? To the extent the terms of the contracts depart
from commodity flows in the cash market, does this have any detrimental
impact on the trading of these contracts?
2. What is the likely effect of failing to modify the current terms
of the contract?
3. To what extent would the alternatives listed by the Commission
increase deliverable supplies on the contracts, and would such
increases be sufficient under the Act?
4. The Commission identified several changes to the CBT Task
Force's recommendations necessary to provide ``a meaningful increase in
the level of economically deliverable supplies available for futures
delivery.'' To what extent is it necessary to permit delivery in off-
water warehouses if delivery on the contract continues to call for
warehouse receipts at warehouses on the Illinois river, which largely
tend to be through-put facilities? What is the range of discounts or
premiums commonly observed in the cash market for corn and soybeans
that would be deliverable in Toledo, East Central Illinois, or the
Northern Illinois River, compared to Chicago?
5. Is modification of the contracts' delivery provisions likely to
enhance or detract from their hedging or price-basing utility?
6. On a related issue, to what extent do the current CBT delivery
specifications for the futures contract for wheat reflect the structure
of the cash market for the underlying commodity? To the extent that the
terms of the futures contract depart from commodity flows in the cash
market, does this have any detrimental impact of the trading of futures
contracts for wheat?
7. What is the likely effect of failing to modify the current
delivery specifications of the wheat contract?
8. What alternatives to the current delivery specifications would
increase deliverable supplies on the wheat contract, while maintaining
its utility for hedging and price basing?
Issued in Washington, D.C., this 19th day of December, 1996, by
the Commodity Futures Trading Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 96-32708 Filed 12-24-96; 8:45 am]
BILLING CODE 6351-01-P